Indicator of Success #3

I enjoy gambling. It's a bit of a confession, because I know that it's not a financially sound position. Even in the most player-friendly games, the house always wins. As a matter of fact, I think that I've only lost money at a casino once in my life, but I know that more a matter of luck than any measure of skill.

But let's look a Hypothetical Bill. Hypothetical Bill has figured out a secret formula to win at roulette. Normally the house has a 51.4% advantage, but Hypo Bill has figured out a method of betting that gives him a 51% chance of winning. In other words, our of every 100 games, he can expect to win 51, which is more than half. Technically this is called statistical arbitrage, a system where you are guaranteed to win over the long term, despite potential losses in the short term.

Hypo Bill walks into the casino with $1,000. He bets $200 on the first and wins $200. Emboldened by his success he bets $500 on the next hand and loses. Trying to make his money back, he bets another $500 and loses again. He's down to only $200. He bets it all and loses once more. Poor Hypo Bill is now broke.

What happened? He was a sure thing to make money when he walked into the casino, so why is he begging for cab fare outside?

He got greedy. The 4th indicator of success is the absence of a get-rich-quick mentality. There was nothing wrong with Bill's system, and he should have been making lots of money. But even when the odds are in your favor, it's still possible to lose. A winning strategy not only has to win more than it loses, but it has to survive those losses as well. If Bill had been betting $1 a hand he could have survived a very long losing streak. Of course it would have taken much longer to build a sweet bankroll.

What's the equivalent of Bill's betting strategy in the real estate world? Well a lot of people make money in real estate, it's not exactly rocket science. But compare Biff and I, with our two properties (each with at least 10% equity), to a beginning investor who has just bought 5 houses with No Money Down.

Let's say that the market stalls a bit and renters and buyers are hard to come by. Biff and I will feel the pain, as we have to dig into our pockets to cover our mortgages. The beginning investor, however, will be digging a hole so deep that he may never recover. Of course, the reverse is true and if the market is soaring then Biff and I won't make nearly as much profit as the newbie. But that's what makes the newbie a gambler and Biff and I investors. We're able to survive both the ups and the downs of the market, the newbie goes to bed every night praying that the market will climb.

How can you identify if you have the get-rich-quick mentality from simply wanting to maximize your investment and get good returns? Stop for a second and think about your past. One aspect of get-rich-quick is a desire to jump on board any idea that sounds lucrative. Not to jump on Casey Serin any more, but as the poster child of the "I deserve to be a millionaire without actually providing any value" generation, here's a subset of the "investments" he has looked into:
-single family homes
-penny stocks
-private equity (at supposedly a 5% return per month)
-cold fusion
-apartment ownership
-brokering large investments (sports teams and casinos)
-sure-fire roulette strategy (yes seriously. He probably meant the Martingale system, which doesn't work and is impossible to implement in modern casinos anyways.)

What's been his return on all of these investments? He's lost around $300k on single family homes, about $3k on penny stocks, and hasn't actually seen any gain from his other ideas.

Compare that to Biff and I, who've focused solely on single family homes (with some 401k's in funds as well) and have made around $30k-$35k each over 26 months, at an ROI of about 147% (about 70% annually). $30k over 26 months isn't going to help us quit our day jobs, but consider our ROI. We've crushed the stock market over this period, and accomplished that without putting our futures at risk. If we had bought 10 times as many properties, we may have made 10 times as much, or we might have gone broke and shattered our credit along the way. As it is, Biff and I are in a solid position to float any of our properties that might struggle, while still being in a good position to slowly expand our holdings.

So take a long look at yourself. If you aren't the type of person who is already maxing out their 401k, and putting money aside every month to invest for the future, then your motivations for pursuing riches in real estate are probably suspect.

Few people become instant millionaires in real estate, and most of those who do, find themselves in deep trouble shortly down the road.


Chris Lengquist said...

Right on. I speak non-stop about the advantages of real estate investing. Investing, not speculating. Not gambling.

Also, I loved that you mention you have a 401K. I do, too. And I mention it every once in a great while and it seems to suprise people? Why. What is wrong with a little diversification?

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